Building a Simple Retirement Plan

A retirement plan will consist of 3 types of input data (Income, expenses and debt) from your budget. In addition you will need to know your savings rate, a rate of return for investments and also make sure you educate yourself or get help along the way from someone which knows about these issues.

Step 1 is to make sure that expenses are less than income. Spend less than you earn, or any financial plan or retirement plan will fall apart. The best way to do this is track your expenses and organize them.

Step 2 is to manage debt. Any debt with an interest rate above 7% probably needs focus more than investments or savings rates. The best way to handle this is to organize and list all debts focusing on interest rates and when the debt will be paid off.

Step 3 is to then look at income, expenses and start building a retirement plan. The details of that plan is discussed below.

The challenge of financial planning is to connect the dots in proper order. Your fixed expenses are one dot, your total expenses are another dot, your income is another dot, your savings rate is another dot, your investments are another dot, the risks you take financially are another dot. A financial plan connects those dots together. Not all people connect them in the same order, or prioritize an issue in the same way. The purpose of this article is to simplify the planning process and show the relationships between some of the data.

If a person focused on income, savings rate and expenses, those 3 factors will influence a retirement plan more than any other factor. These are also what a person has the most control over.

1) Savings rate is calculated from gross income. It is the percentage you save each year. For example if you gross $40,000 per year, a 20% savings rate means you save $8000 per year ($8000 is 20% of $40,000). 2) Expenses are generally calculated from net (take home) pay. In same $40,000 example, that $40,000 is taxed, so its very possible a person takes home (and spends) about $2400 per month. The expenses need to focus on the spending level- so $2400 per month, or $28,800 per year. 3) Try to make sure all numbers are consistent- if savings is $8000 per YEAR make sure that the $2400 of expenses are calculated per year (multiply by 12). When tracking expenses this is important because some people might get gas 1-2 times per week, get groceries 2 times per month, and the electric bill might only be due once per month. Make sure the expenses are all measured per year so the plan is consistent.

Focus on savings rate above all else. The cure to a retirement planning problem is savings rate. If you increase your savings rate the plan will eventually fix itself, even if you don’t invest the money as effectively as someone else.

In the example above, a $40,000 income with a 20% savings rate was used. This means a person is living on 80% of their gross pay (and also paying taxes and other expenses from the 80%). If the savings rate increased to 25%, then that person is living on 75% of their gross pay. The two numbers must always add to 100% (20%+80%=100% or 25%+75%=100%).

The best way to start a retirement plan is to start with a modest savings rate. 6% is modest, and 10% is a good target within 5 years of starting your financial plan. Progress will be slow at first, when the savings rate hits 20% the plan will accelerate and success is achieved much quicker.

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